Thank You

Error.

As retail stocks go,
Kohl'sKSS -0.3250975292587776%Kohl's Corp.U.S.: NYSEUSD61.32
-0.2-0.3250975292587776%
/Date(1438376658885-0500)/
Volume (Delayed 15m)
:
1343267AFTER HOURSUSD61.32
%
Volume (Delayed 15m)
:
114205
P/E Ratio
14.274407560873412Market Cap
12133756693.7634
Dividend Yield
2.935420743639922% Rev. per Employee
139241More quote details and news »KSSinYour ValueYour ChangeShort position
has been about as interesting in the past three years as a pair of khaki pants. On second thought, the khakis win this contest: Shares of the midpriced apparel, accessories, and housewares chain have risen all of 3.6%, to $54.74, in this span, while the Standard & Poor's 500 has surged 48%.

Kohl's, which operates 1,158 stores in 49 states, has been hampered by lackluster merchandising, inventory imbalances, and constricted profit margins. Bearish investors cite the company's inability to recruit and carry the most desirable brands.

Kohl's operates 1,158 stores across the country, including this unit in San Rafael, Calif.
Eric Risberg/AP Photo

Yet, skeptics could be surprised in the next year as Kohl's finally begins to live up to its retail motto, "Expect Great Things." A constellation of merely good things, including improvements in the merchandise assortment, private-label programs, and the online business, as well as cost-cutting, could result in modest revenue growth and higher pretax margins, which in turn could lift the shares (ticker: KSS) by more than 20%, into the mid- to high-$60s.

The bullish case for Kohl's, based in Menomonee Falls, Wis., begins with the retailer's shareholder-friendly capital-allocation policies. From 2010 through 2012 the company bought back $4.6 billion worth of shares, shrinking its market capitalization by 30%, and it plans to continue shopping. It also initiated a dividend in 2011, which it has raised steadily to a current $1.40 a share. The stock yields 2.6%.

THESE MOVES PROVIDE "a fair amount of valuation support," John Linehan, head of U.S. equity at T. Rowe Price, told Barron's in a recent interview ("Why a Pro Likes Apache, Southwest, and Kohl's," Sept. 16). The Baltimore-based money manager owned nearly 12% of Kohl's as of June 30.

Making nice to shareholders gives management some breathing room. While Kohl's declined to make its top executives available for interviews, the company acknowledged in recent conference calls with analysts that it knows there is work to do.

Kohl's earned $986 million, or $4.17 a share, in the fiscal year ended Feb. 2, down from $4.30 in fiscal 2012. Revenue rose 2.7%, to $19.3 billion, as sales at stores open at least a year inched up just 0.3%. But sales growth came at the expense of profitability: Gross profit margins contracted to 33.3% from 36.2% a year earlier, pressured by markdowns.

Kohl's is expected to earn $4.24 a share in the current fiscal year, and $4.65 in fiscal 2015, reflecting operating improvements. Investors have their doubts, however, as the stock fetches just 11.6 times the fiscal 2015 earnings estimate, a 30% discount to the department-store industry. In the early 2000s Kohl's was considered a stock-market darling, with a P/E above 30.

After a period of misjudging demand, Kohl's is getting better at inventory management. Inventories rose 6% in the August quarter, a comforting contrast to the second quarter of fiscal 2013, when they spiked by double digits. "We have plenty of opportunity to improve our gross margins in the future just from better inventory management," Chief Financial Officer Wes McDonald told analysts in August.

KOHL'S ALSO HOPES that personnel changes will help to burnish the retailer's appeal to shoppers. The company announced in May that it had hired Michelle Gass, a high-ranking
StarbucksSBUX -0.22390630382363072%Starbucks Corp.U.S.: NasdaqUSD57.93
-0.13-0.22390630382363072%
/Date(1438376400310-0500)/
Volume (Delayed 15m)
:
6174553AFTER HOURSUSD57.84
-0.09-0.15535991714137753%
Volume (Delayed 15m)
:
344975
P/E Ratio
32.70479308982104Market Cap
85979703624.3286
Dividend Yield
1.1047816330053513% Rev. per Employee
96434.6More quote details and news »SBUXinYour ValueYour ChangeShort position
(SBUX) executive who helped launch the Frappuccino, as its first-ever chief customer officer, in charge of marketing, e-commerce, and "omnichannel experiences." Although it is too early to assess her impact, Kohl's won plaudits for reaching outside its ranks for talent.

The Bottom Line

Kohl's shares, at $54.74, have been dead money for awhile. The stock could rally to the mid-$60s, however, as recent merchandising moves pay off.

Under Gass, Kohl's is revising its marketing to stress "a broader message" of savings and value, instead of an emphasis on individual products and categories. She will also be integrating e-commerce, now around 7% of sales, with the stores, in part through the increased use of in-store ordering kiosks. Next year the retailer will launch in-store delivery of online orders.

Kohl's has cut back sharply on new store openings, with 12 planned for this year, compared with 40 in 2011. Instead, the company is using more of its free cash, which totaled $381 million in fiscal '13, to remodel existing stores, update information technology, and reward shareholders directly. One recent IT purchase: electronic signage on the racks, which makes it easier to update prices quickly.

ONE RAP AGAINST Kohl's is the company's inability to attract enough national brands, which drive store traffic. Private-label and exclusive brands account for 56% of sales, up from 37% in 2007, according to Credit Suisse. Exclusive brands include Bobby Flay in kitchenware, Dana Buchman in apparel, and Jennifer Lopez in multiple categories, including apparel, jewelry, and bedding. These brands are more profitable for Kohl's than national brands, but spur less store traffic.

To induce more national brands to sign on with Kohl's, the company is giving them more attention in its advertising and improving store presentation. Such initiatives look to be having a positive effect. The quarter ended Feb. 2 marked the first in several years in which national brands grew on a "comp-store" basis, CEO Kevin Mansell told analysts. And in the latest quarter, Kohl's saw mid- to high-single-digit sales gains in Carter's, Lee, Levi's, and Nike—its four largest national brands.

Kohl's earned $1.04 a share in the period, up from $1 a year earlier, on a 2% revenue increase to nearly $4.3 billion. Same-store sales rose 0.9%.

Spiffing up Kohl's will take time, but smart moves by management, and a sweet dividend, offer reasons to stick around. One of these days, when things click in the stores and the stockrooms, Kohl's stock will be khaki no more.